China Manufacturing: Bad Contracts and Bad Times Lead to Bad Products

Not entirely sure why, but in the last couple weeks our China lawyers have seen a massive increase in emails and phone calls from North American companies seeking our help in dealing with defective products/quality control problems. In this post, I explain what you (and they) need to have in place to avoid these sorts of problems in the future, and to make it possible to resolve such problems should they occur. Our China attorneys also have been receiving an unusually high number of emails and phone calls from companies being pursued by Sinosure, and I will discuss how to deal with that in a future post.

My theory is that this slew of calls is due to two things. An increase in QC problems at China factories due to rising costs. Whenever costs rise for China factories quality problems rise as well, until such time as the China companies can increase their prices to their foreign buyers. This influx of bad product calls may also simply be due to the time of year; it may just be the end of 2016 hangover. I note that our last bit tick in these calls was in February 2016. What makes this year’s version so much more interesting for us anyway, is how many of these new matters involve Internet of Things products and how woefully unprepared these companies are to deal with these problems.

I am going to try to avoid getting all preachy here, but I truly do believe that all of these companies could have avoided their bad product problems had they had a good contract in place with their China product supplier. Only one of the companies that have contacted us so far this year had any contract at all with their China factory, and that one contract called for all disputes to be resolved in the U.S. Court of the American buyer, and as we have discussed constantly on here, that is 99.99% of the time a non-starter. In Four Common (And Somewhat Deadly) China Law Mistakes To Avoid, I briefly (for me anyway) gave a real life example as to why this is such a bad idea:

A lawyer calls us with an airtight $2 million dollar breach of contract lawsuit against a Chinese company. This lawyer had drafted a contract calling for disputes between her client and the Chinese counter-party to be resolved in Boston Federal Court and she had already sued the Chinese company in Boston and secured a default judgment against it. She was now seeking my law firm’s help in domesticating the judgment in China, and It was clear she expected us to jump at the opportunity to take the case on a contingency fee basis.

That is until we told her that China does not enforce U.S. judgments. Ever.

She then came up with the idea that we start all over by suing the Chinese company again in China. We had to tell her that could not work because the Chinese court would have two strong grounds for throwing out that lawsuit. First, improper jurisdiction because the contract clearly called for the lawsuit to be in Boston. Second, res judicata because the entire case had already been tried (and won) in Boston (the proper jurisdiction). I have no idea how she explained all this to her client.

American lawyers commonly assume that what makes sense for a domestic transaction necessarily also makes sense for an international transaction. Boston would have made sense in the above instance if the counter-party had been in Los Angeles, but the rules and the issues are different when doing business internationally.

If you check out this post, China Contracts that Work, you will see that what is needed for you to have a manufacturing contract that works is for that contract to be in Chinese with a provision calling for disputes to be resolved in a Chinese court under Chinese law. Your manufacturing contract should also contain a liquidated damages provision and a mold protection provision (so that the factory does not keep your molds if there is a dispute, and be properly chopped/sealed by the Chinese side. It is also critical that your contract be with the right Chinese company as Chinese companies are notorious for signing agreements with an essentially empty shell company, usually based in Hong Kong. If your contract satisfies all of these things, the odds of your having a manufacturing problem go way way down. And if you have such a contract and you do have a problem, your odds of being able to resolve it with your Chinese factory without having to contact a China law firm for legal assistance go way way up. And in those rare instances where you do need to engage a China attorney to assist, that attorney will be well positioned to resolve your problem relatively quickly.

One more thing. Whenever someone contacts our law firm with a problem with their factory, one of the first things we always ask them is whether they have secured China trademarks for their trade name and their brand and their logo. We then explain how common it is for Chinese factories (they actually have someone else do the filing for them) to go off and register YOUR brand name and YOUR logo as a trademark so that they can use this as leverage against you or so that they can keep making your product with your brand name and your logo and sell that product in any country in the world where you have not protected them with a trademark. Sadly, about half the time we are too late and the trademarks have already been registered to someone else, making it difficult or even impossible for the foreign buyer to continue having its products made in China. For more on this critical IP issue, check out When to Register your China Trademark. Ask Tesla and China: Do Just One Thing, Trademarks. So if you have not already registered your brand names and logos in China, you should do this IMMEDIATELY and you certainly should do so before you complain to anyone there.

We will be discussing the practical aspects of Chinese law and how it impacts business there. We will be telling you what works and what does not and what you as a businessperson can do to use the law to your advantage. Our aim is to assist businesses already in China or planning to go into China, not to break new ground in legal theory or policy.